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April 2020

The CARES Act Increases Availability of Bankruptcy Reorganization to Small Business Debtors

April 17, 2020

To make reorganization under Chapter 11 more accessible and cost-effective for small businesses, Congress passed the Small Business Reorganization Act of 2019 (“SBRA”).  The SBRA took effect on February 19, 2020, immediately prior to the world wide spread of COVID-19, the resulting stay at home orders, shuttering of businesses and unprecedented economic fallout.   In response to the collapsing economy, on March 27, 2020, Congress passed the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) to provide economic relief to individuals and business impacted by the COVID-19 pandemic. 

Notably, the CARES Act expanded small business eligibility under the SBRA to small businesses with secured and unsecured debt of less than $7.5 million, an eligibility increase of over $4.7 million.  The increased eligibility for relief made available by the CARES Act is temporary and expires on March 27, 2021.  

During this difficult time, SBRA, as revised by CARES, may provide a solution for many of the small businesses suffering economic distress.  It is anticipated that many small businesses nationwide will take advantage of the streamlined reorganization provisions of the SBRA and increased access made available by CARES.

The SBRA provisions are set forth in Subchapter V of Chapter 11 of the Bankruptcy Code.  SBRA contains a number of significant modifications to traditional reorganization under Chapter 11, all of which are intended to shorten the process, decrease cost and provide the small business debtor with greater power to adjust its debts and emerge from bankruptcy. Those newly enacted provisions include:

  • Proposal of a Plan of Reorganization:  In a small business debtor case, only the debtor can propose a plan.  The plan must be filed within 90 days of filing bankruptcy.  Importantly, the small business debtor is not required to file or obtain approval of a separate disclosure statement, which will greatly reduce the time and cost of the Chapter 11 bankruptcy.  The plan must contain a brief history of the debtor’s operations, a liquidation analysis, future projections and provide for payment of all or a portion of disposable income of the debtor to the supervision and control of trustee as is necessary for the execution of the plan. 
  • Confirmation of a Plan:  Unlike a typical Chapter 11 bankruptcy, the SBRA plan can be confirmed without requiring the traditional, often extensive, negotiations with creditors over consent or support of the plan.  Importantly, confirmation of the SBRA plan does not require the consent of an impaired class of creditors.  The plan must not discriminate unfairly and must be fair and equitable as to all classes of claims.  To be fair and equitable to unsecured creditors, the debtor must pay all of its projected disposable income to its creditors under the plan for a period of 3 to 5 years.
  • Absolute Priority Rule:  Section 502 of the Bankruptcy Code requires a debtor to pay all creditors in full, including unsecured creditors, before owners are able to retain their ownership interests.  In a significant departure from traditional reorganizations under Chapter 11, under the SBRA, owners can retain their ownership interest if the plan does not discriminate unfairly among creditors, is fair and equitable and provides that the small business debtor will contribute all of its projected disposable income to the plan.
  • Administrative Claims:  Unlike a traditional chapter 11, the small business debtor no longer has to pay administrative claims in full on the effective date of the plan.  Instead, small business debtors can pay administrative claims through the 3-5 year plan term.
  • Elimination of Unsecured Creditors’ Committee: Under the SBRA, a committee of unsecured creditors is not appointed unless the court orders otherwise, which is expected to result in a significant cost-savings for the debtor.
  • Appointment of a Trustee:  Pursuant to the SBRA, a trustee will be appointed to, among other things, help facilitate the development of a consensual plan of reorganization, collect and disburse plan payments and monitor and evaluate debtor’s operations and compliance with the Bankruptcy Code.  The service of the trustee generally terminates when the plan is substantially consummated. 
  • Modification of Residential Mortgages:  The SBRA also allows small business debtors to modify secured loans on their personal residences if the loan was acquired in connection with the small business of the debtor. 

The SBRA remains in its infancy and is only recently being implemented and tested in bankruptcy courts nationwide.  Certainly, the SBRA provides benefits to small business debtors and conversely presents new challenges to creditors to preserve and protect their rights. 

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Bankruptcy, Restructuring & Creditors' Rights

Megan M. Adeyemo
Jeffrey D. Cawdrey

Bankruptcy, Restructuring & Creditors' Rights